Small Business Financing Options That Bypass Traditional Banks

Business financing options without a traditional bank

If your small business needs capital but doesn’t qualify for a traditional bank loan, certain alternative financing methods and lenders may meet your needs. Here are some of the top financing options for startups and small businesses.

1. Community development finance institutions

There are thousands of nonprofit community development finance institutions (CDFIs) across the country, all providing capital to small business and microbusiness owners on reasonable terms, according to Jennifer Sporzynski, senior vice president for workforce and business development at Coastal Enterprises Inc. (CEI).

“A wide variety of applications for loans come across our desk every week, many of them from ambitious startups,” Sporzynski said. “As a mission-oriented non-bank lender, we know from experience that many viable small businesses struggle to access the capital they need to get started, thrive and grow.”

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Lenders like CEI differ from banks in a few ways. First, many lenders look for a certain credit score, and that rules out a lot of startups. If banks see “poor credit,” that business will almost always end up in the “no” pile. CDFI lenders look at credit scores too, but in a different way.

“We look for borrowers who have been fiscally responsible, but we understand that unfortunate things happen to good people and businesses,” Sporzynski said. “We seek to understand what happened and assess its relevance.” [See more information on choosing the right small business loan for you.]

For instance, personal or family medical issues and job losses can negatively impact a borrower’s accounting, but those can be explained. Also, CDFI lenders do not need nearly as much collateral as a traditional bank would. Other things can compensate for a lack of assets to be used as collateral.

2. Venture capitalists

A venture capitalist (VC) is an outside group that takes part ownership of the company in exchange for capital. The percentages of ownership to capital are negotiable and usually based on a company’s valuation.

“This is a good choice for startups who don’t have physical collateral to serve as a lien to loan against for a bank,” said Sandra Serkes, CEO of Valora Technologies. “But it is only a fit when there is a demonstrated high-growth potential and a competitive edge of some kind, like a patent or captive customer.”

The benefits of a VC are not all financial. The relationship you establish with a VC can provide an abundance of knowledge, industry connections and a clear direction for your business.

“A lot of entrepreneurs lack the skills needed to grow a business, and even though they can make money through sales, understanding how to grow a company will always be a lost cause in the beginning,” said Chris Holder, author of Tips to Success and CEO and founder of the $100 Million Run Group. “The guidance from an experienced investor group is the best thing, as the mentorship is key for everyone.”

3. Partner financing

With strategic partner financing, another player in your industry funds the growth in exchange for special access to your product, staff, distribution rights, ultimate sale or some combination of those items. Serkes said this option is usually overlooked.

“Strategic funding acts like venture capital in that it is usually an equity sale – not a loan – though sometimes it can be royalty-based, where the partner gets a piece of every product sale,” she added.

Partner financing is a good alternative because the company you partner with is usually going to be a large business and may even be in a similar industry, or an industry with an interest in your business.

“The larger company typically has relevant customers, salespeople and marketing programming that you can tap right into, assuming your product or service is a compatible fit with what they already offer, which would surely be the case or there would be no incentive for them to invest in you,” Serkes said.

4. Angel investors

Many think that angel investors and venture capitalists are the same, but there is one glaring difference. While a VC is a company (usually large and established) that invests in your business by trading equity for capital, an angel investor is an individual who is more likely to invest in a startup or early-stage business that may not have the demonstrable growth a VC would want.

Finding an angel investor can also be good in a similar way to gaining funding from a VC, albeit on a more personal level.

“Not only will they provide the funds, [but] they will usually guide you and assist you along the way,” said Wilbert Wynnberg, an entrepreneur and speaker based in Singapore. “Remember, there is no point in borrowing money just to lose it later. These experienced businesspeople can save you tons of money in the long run.”

5. Invoice financing or factoring

With invoice financing, also known as factoring, a service provider fronts you the money on your outstanding accounts receivable, which you repay once customers settle their bills. This way, your business has the cash flow it needs to keep running while you wait for customers to pay their outstanding invoices.

Eyal Shinar, co-founder of small business cash flow management company Fundbox, said these advances allow companies to close the pay gap between billed work and payments to suppliers and contractors.

“By closing the pay gap, companies can accept new projects more quickly,” Shinar said. “Our goal is to help business owners grow their businesses and hire new workers by ensuring steady cash flow.” 

6. Crowdfunding

Crowdfunding on platforms such as Kickstarter and Indiegogo can give a financial boost to small businesses. These platforms allow businesses to pool small investments from several investors instead of seeking out a single investment source.

“As an entrepreneur, you don’t want to spend your investment options and increase the risk of investing in your business at such an early age,” said Igor Mitic, SEO manager at 2am.technologies. “By using crowdfunding, you can raise the necessary seed funds to get your startup through the development phase and ready to be pitched to investors.”

7. Grants

Businesses focused on science or research may receive grants from the government. The U.S. Small Business Administration (SBA) offers grants through the Small Business Innovation Research and Small Business Technology Transfer programs. Recipients of these grants must meet federal research and development goals and have a high potential for commercialization. [Read related article: How to Secure a Business Grant]

8. Peer-to-peer or marketplace lending

Peer-to-peer (P2P) lending is an option for raising capital that introduces borrowers to lenders through various websites. Kiva and SoLo are two of the most notable P2P lending platforms in the U.S.

“In its simplest form, a borrower creates an account on a peer-to-peer website that keeps records, transfers funds and connects borrowers to lenders,” said Kevin Heaton, CEO and founder of i3. “It’s Match.com for money. A key difference is in borrower risk assessment.”

According to the SBA, P2P lending can be a solid financing alternative for small businesses, especially amid post-recession credit markets. One drawback of this solution is that P2P lending is available to investors in certain states only.

This form of lending, made possible by the internet, is a hybrid of crowdfunding and marketplace lending. When platform lending first hit the market, it allowed people with little working capital to give loans to other people – peers. Years later, major corporations and banks began crowding out true P2P lenders with their increased activity. In countries with better-developed financial industries, the term “marketplace lending” is more commonly used.

9. Convertible debt

Convertible debt is when a business borrows money from an investor or investor group and the collective agreement is to convert the debt to equity in the future.

“Convertible debt can be a great way to finance both a startup and a small business, but you have to be comfortable with ceding some control of the business to an investor,” said Brian Cairns, founder of ProStrategix Consulting. “These investors are guaranteed some set rate of return per year until a set date or an action occurs that triggers an option to convert.”

Another benefit of convertible debt is that it doesn’t place a strain on cash flow while interest payments are accrued during the term of the bond. A drawback of this type of financing is that you relinquish some ownership or control of your business.

10. Merchant cash advances

A merchant cash advance is the opposite of a small business loan in terms of affordability and structure. While this is a quick way to obtain capital, cash advances should be a last resort because of their high expense. Many of the best credit card processing services offer this option, so check with your provider to see if this could be a form of capital to explore

“A merchant cash advance is where a financial provider extends a lump-sum amount of financing and then buys the rights to a portion of your credit and debit card sales,” said Priyanka Prakash, technical writer at Amazon Web Services. “Every time the merchant processes a credit or debit card sale, the provider takes a small cut of the sale until the advance is paid back.”

Prakash says that while this appears to be convenient, cash advances can be very expensive and troublesome to your company’s cash flow. If you can’t qualify for a small business loan or any of the options above, only then should you consider this option.

11. Microloans

Microloans (or microfinancing) are small loans given to entrepreneurs who have little to no collateral. Microloans sometimes have restrictions on how you can spend the money, but they typically cover operational costs and working capital for equipment, furniture and supplies. One example of a small business microlender is Accion, which offers microloans of $5,000 to $100,000. Another example are SBA microloans administered by nonprofit organizations.

Why is it difficult for small businesses to get loans from banks?

Capital is difficult for small businesses to access for several reasons. It’s not that banks are against lending to small businesses – they want to – but traditional financial institutions have an outdated, labor-intensive lending process and regulations that are unfavorable to local shops and small organizations. 

The difficulty of accessing capital is exacerbated because many small businesses applying for loans are new and banks typically want to see at least a five-year profile of a healthy business (for instance, five years of tax data) before extending an offer.

What is alternative financing?

Alternative financing is any method through which business owners can acquire capital without the assistance of traditional banks. Generally, if a funding option is based entirely online, it is an alternative financing method. By this definition, options such as crowdfunding, online loan providers and cryptocurrency qualify as alternative financing.

Why might small businesses seek alternative financing?

There are several reasons why small business owners might turn to business loan alternatives. Here are three of the most common.

• Lower credit requirements: Traditional banks are almost certain to decline loans to borrowers with a credit score below a certain threshold, often between 600 and 650. [Read related article: How to Build Business Credit]
• Easier qualification: Not all small business owners meet the additional requirements to apply and be approved for traditional loans. In these cases, business loan alternatives are helpful.
• Faster approval: Traditional bank loans can take weeks to be approved, whereas some business loan alternatives give you access to funding in as little as one day.

The benefits of alternative lending

Startups can enjoy a few key benefits in securing funding from a nontraditional source. With alternative loans, a business owner gets a strong, invested partner who can introduce them to new clients, analysts, media and other contacts.

These are some other benefits of working with a nontraditional lender.

• Market credibility: The startup gets to “borrow” some of the goodwill that the strategic partner has built up, and working with an established investor lends weight to the brand.
• Infrastructure help: The larger partner likely has teams for marketing, IT, finance and HR – all of which are things a startup could “borrow” or utilize at a favorable rate.
• Overall business guidance: It’s likely the strategic partner will join your board as part of the investment. Remember that they have a wealth of experience in business, so their advice and viewpoint will be invaluable.
• Relatively hands-off partnership: A strategic partner still has their own business to run, so they are unlikely to be very involved in the day-to-day operations of the startup. Occasional updates on your business, such as monthly or quarterly, are usually sufficient check-ins for them.

All businesses need working capital to thrive. Without the appropriate business financing options, startup companies are likely to fail. Avoiding the traditional bank loan route might seem like an impossible feat, but there are a plethora of small business financing options readily available for entrepreneurs. Gathering the right market data research and implementing the best financing option for your company will increase the chances of your business surviving for the long haul.

How can small businesses prepare to apply for alternative lending options?

Applying for financing entails much more than just filling out an application. To increase your chances of getting financing, small business owners should do their homework and have a strategy.

Here are five tips to help you prepare your business for financing success:

1. Know how much you need to borrow upfront. When you apply for business loan alternatives, you’ll likely find that many different loan amounts are available. Don’t commit to borrowing more than you need; there may be penalties for early repayment or for not using your whole loan.
2. Write a business plan with financial projections. While not all alternative financing providers will demand to see your business plan, many funding sources have this stipulation, so you should prepare your plan now. [Read related article: Guide to Creating a Business Plan With Template]
3. Do market research and know the conditions of your industry. Lenders may be more likely to approve borrowers in growing industries. As such, if you can prove that your company’s sector or market primes your business to expand and succeed, present your argument firmly somewhere in your application. It also demonstrates your knowledge as an entrepreneur and business strategist.
4. Know your credit score. Often, a credit score below a certain number is an immediate disqualifier for a loan, even if your company is primed for rapid growth and you’re working on repaying your loans. Find out your credit score, and if it is too low, work to improve it before seeking capital. 
5. Meet with a small business expert and attend training provided through the SBA. As with any important small business decision, you shouldn’t go this one alone. Consult experts and seek training on how to apply successfully for the funding your company needs to thrive.

As a small business owner, you should also establish a strong online presence and pay attention to how your company looks online, because lenders will be reviewing this information too. Online review sites such as Yelp, Angi and TripAdvisor help paint a picture of your operations and serve as an indicator of your overall business health. Social connections and customer relationships on social media can also play a role in a lender’s decision to offer financing.

How to find business financing options

Trying to find financing for your startup can easily turn into a full-time job. From building a network of investors to connecting with other founders, financing is at the heart of any business’s success, but it can turn into a serious time commitment.

However, by working with the right investors and taking the time to be purposeful in your pitch, you can take important steps toward funding your company. Make no mistake: It will be difficult, but by being precise in your search, you can position yourself for success.

“What I find is when people get lots and lots of rejection and little progress, oftentimes they’re just talking to the wrong investors,” said Mike Kisch, CEO of Aktiia. “If they had a better sense as to who the right investor was, they’d see their success rate go up fairly dramatically.”

How to use warm introductions

The key to obtaining funding as a startup is the “warm introduction,” according to Casey Berman, managing partner of VC firm Camber Creek. Berman said startup founders can look to their immediate network to try to find opportunities. While this includes obvious connections – like friends and family or other startup owners – it’s also important to consider professional services your company is using. If, for example, you work with a legal consultant or PR company, they may be able to help you find funding, he said.

The key, said Berman, is to partner with a company, whether it’s an investment firm or a payroll processing service, that adds value to your business.

“The warm introduction goes a lot further than really any other potential avenue,” he said. “Any professionals that are surrounding the company should absolutely be the first stop and the first location a company goes to try to have access to venture capital and a warm introduction.”

This is how you can differentiate your startup from its peers. Building a network of individuals that help pull your company up is the best way to give your business the support it needs. 

How to target a venture capitalist for business financing

Venture capital may be the most difficult to secure, primarily because VCs have very specific investment strategies, want to invest for a relatively short period of time (three to five years) and may want to be involved in your business’ operations and decisions. VCs also usually want to invest sums larger than a few million dollars.

Most startups begin with early seed funding from friends and family, angel investors, or accelerators. If you’re already past this step and are looking for longer-term funding, it’s important to approach VC firms the right way. Kisch said it’s crucial to find the right investor for the stage your business is in. There are thousands of VC firms out there, so think critically about your business and which investors make the most sense.

“Finding the right investor who is at the right stage of where your company is but also has some exposure to the environment that you’re going to be in – I think that’s the best way that you’re going to have a productive relationship,” Kisch said.

Once you’ve developed a shortlist of VCs that invest in your space and can provide the level of guidance and added value you’re looking for, it’s time to set up a formal process.

With your list in hand, Berman recommends spending one to two weeks trying to make that initial contact with the company. Once you’ve made contact, keep the company up to date on business developments and other information that are relevant to that investor. This ongoing conversation can help you build relationships with investors. When it’s time to raise funding, you’ll have to pitch the VC firms you’ve been in constant communication with.

“The CEO really needs to commit to raising money and doing what’s called a roadshow to get in front of a large number of venture funds to find the right partner,” Berman said.

Berman said the whole process, from initial meetings to closing a deal, can take anywhere from 60 to 90 days, or even longer, so plan accordingly. He also recommended looking for funding well before your business will need it.

How to stay motivated when searching for small business financing

One of the biggest variables throughout this process is motivation. For a startup, rejection is part of the journey. Staying motivated during trying times can be difficult, but it will be the backbone of your business’s success.

Kisch has been through five rounds of funding with various startups he’s worked for. He said one thing that has been helpful for him throughout the screening process is that he has tried to maintain low expectations so that rejection doesn’t overwhelm him. Rather than seeing it as a failure, Kisch sees rejection as part of the process.

“If someone says no, I just think, ‘That’s cool. I guess I’m just one step closer to a yes,’” he said.

The other takeaway from rejection is how you adapt and respond. Kisch said that a stream of critical feedback allows you to better your product and hone your pitching skills.

He said a good way to think about it is you’re not getting rejected because your idea or product is bad; it’s because it can be slightly improved or you haven’t developed the skills to pitch it in the most effective way. This keeps the responsibility in your hands without adding any pressure. Everything is a work in progress, and even today’s most successful companies had to deal with challenges at one point.

“Raising money from people is a very difficult thing,” he said. “You just have to sort of roll with it and be aware that there are a lot of companies that were initially rejected that became generation-defining companies.”

Banking on success – without banks

Although banks were once the tried and true way to obtain business funding, that’s not the case anymore. Alternative lenders, ranging from angel investors to invoice financing companies, offer more accessible funding that may fit your needs just as well. With these funding options, you can laugh all the way to the bank – without ever actually going to the bank.

Max Freedman and Matt D’Angelo contributed to this article. Source interviews were conducted for a previous version of this article.